Producers’ migration to liquids-rich shale plays in pursuit of higher returns in a low-gas price era has been good for the midstream energy sector, which can look forward to increased capital spending and a robust environment through the middle of next year and possibly beyond, according to a new report from Moody’s Investors Service.

Moody’s has a “positive” outlook on the midstream sector for the next 12-18 months. The ratings agency forecasts that earnings before interest, taxes, depreciation and amortization for the sector will grow by more than 20% in 2012. Growing production of oil, natural gas and natural gas liquids (NGL) and higher margins are driving increased earnings and cash flow for midstream companies, Moody’s said.

“Rising North American production will give midstream energy companies both higher earnings and more demand for new infrastructure through mid-2013,” said Pete Speer, a Moody’s vice president and author of the report. “We see midstream sector capital spending increasing by over 60% in 2012 as companies try to meet the strong demand for new infrastructure.”

Elevated oil and NGL prices have driven high drilling activity by North American exploration and production companies, which in turn has increased demand for new midstream infrastructure, said Moody’s. This is expected to offset the decline in natural gas-directed drilling caused by natural gas prices, which are at 10-year lows.

“High oil prices will continue to support drilling by exploration and production companies (E&P) in North America because they justify the cost of developing technically difficult plays,” the ratings agency said in its report. “Drilling activity continues to grow in oil-producing plays, including [the] Bakken in North Dakota and Montana and [the] Eagle Ford in southern Texas. E&Ps are also exploiting other unconventional reservoirs in established producing areas, including the prolific Permian Basin of West Texas, [the] DJ [Denver-Julesburg] Basin of northeastern Colorado and the Uinta Basin in Utah.”

On Monday Moody’s placed on review for possible upgrade the ratings of numerous upstream companies. Among them: Stone Energy, Laredo Petroleum, Energy XXI Gulf Coast Inc., Baytex Energy, Oasis Petroleum, Clayton Williams Energy Inc., Carrizo Oil & Gas Inc., Plains Exploration, PDC Energy, Rosetta Resources, W&T Offshore Inc., Swift Energy, Antero Resources LLC and Concho Resources Inc. The ratings agency cited the companies’ exposure to oil/liquids as the reason for their improved outlooks.

Moody’s said NGL prices remain attractive for continued drilling and production in natural gas properties where there is high liquids content, such as in the wet gas sections of the Eagle Ford and Marcellus shales, as well as the Granite Wash. “At 2012 prices, NGLs offer producers an extra $1-3/MMBtu of natural gas that they produce,” the firm said. “This significantly boosts their returns on investments from this drilling, despite the very weak natural gas prices that we expect to persist into 2013.

“While midstream company margins for natural gas processing are likely to narrow in 2012…we expect natural gas processing margins to remain above five-year historical averages during 2012. NGL prices should also keep NGL volumes growing through 2013.”

The outlook is not without risks. For instance, “a complete collapse in natural gas prices — which could happen if storage capacity were to fill completely in the summer or fall, for example — would lead to bigger production shut-ins and would hurt midstream earnings in the second half of 2012,” Moody’s said. “Lower commodity prices would not only reduce earnings in such price-sensitive business lines as gas processing, but would also reduce production volumes as E&Ps pull back on drilling activity.”

Moody’s highlighted the largest and most diversified midstream players as the ones reaping the benefit from this demand, especially those with existing gathering and processing or pipeline infrastructure near booming shale plays. The report said Energy Transfer Partners, Enterprise Products Partners, Oneok Partners and Williams Partners are among those best positioned for organic growth.

In addition, Moody’s said low interest rates — and the sector’s lower commodity price sensitivity — have made the midstream sector very attractive to equity investors, while both high-yield and investment-grade midstream companies are able to tap the open capital markets for funding to fuel growth.

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